GlaxoSmithKline (LSE: GSK) and Quindell (LSE: QPP) are both heavily traded by private investors. But thats where the similarity ends.
At todays prices, Id be happy to double my holding in Glaxo if I had the cash. Yet Id have no hesitation in selling shares in Quindell, especially after Wednesdays surprise 8% gain.
Heres why.
1. Is my capital safe?
One of the best ways to make money in shares is to avoid big losses. As Warren Buffett famously said, Rule number one is never lose money. Rule number 2 is never forget rule number one.
A large part of Quindells 91p share price is based on the expectation that the firm will make good on its promise to return 100p per share to shareholders. This money came from the sale of the firms legal services division to Australian firm Slater & Gordon.
Yet this payout isnt safe. Quindell is under investigation by the Serious Fraud Office. This process could generate massive legal costs and potentially some fines. If I was a director at Quindell, Id be inclined to hang on to the cash until I was sure it was surplus to requirements.
If the 100p payout is reduced or cancelled, Quindell shares will plummet. Shareholders could face a permanent loss of capital.
This is not a serious risk at Glaxo. The firms valuation may vary over the years, but it is backed by real assets which generate cash flow and profits and have a marketable value.
Glaxos conduct may not always be perfect, but the firm is able to weather such storms thanks to its scale and diversity.
2. The message from the market
Glaxo shares currently trade on a forecast P/E of 18.5 and have a price-to-sales ratio of 3. This may not seem especially cheap, given the firms current weak earnings. However, this strong valuation is a measure of the markets confidence in the long-term earning power of Glaxos assets.
Many institutional investors, such as Neil Woodford, believe that Glaxos current valuation does not reflect the longer-term potential of its product portfolio.
Thinking along the same lines, what does Quindells current valuation suggest about the markets view of the firm?
Quindell currently has a market capitalisation of just 405m. Thats less than the firms 535m cash balance and less than the 450m which would be returned to shareholders if the 1 per share payout goes ahead.
The implication is clear, in my view. The market doesnt see much value in Quindells remaining businesses and is pricing in a reduction to the planned 100p per share payout.
3. Profit, cash flow and dividends
The final reason Id buy Glaxo and sell Quindell is that the pharmaceutical firm is the only one of these companies that operates like a sustainable business.
Glaxos operating margin has averaged 22.9% over the last five years. In this time its generated 19.5bn of after-tax profits and paid 367p per share in dividends.
In contrast, over the same period Quindell has reported post-tax losses totalling 411m and paid 1.5p per share in dividends. Its also facing a Serious Fraud Office investigation.
Which company do you think is more likely to be a successful investment?
I plan to buy more shares in Glaxo over the coming weeks, and I’m not alone.
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Roland Head owns shares of GlaxoSmithKline. The Motley Fool UK has recommended GlaxoSmithKline. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.